Macquarie outlines a solution that could ease pressure on the RBA to cut rates

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  • The RBA expects the Australian economy will grow above 3% per annum over the next three years, helping to lower unemployment and boost wage and inflationary pressures.
  • Macquarie Bank says those optimistic forecasts are unlikely to be achieved, predicting growth will undershoot by some margin, making progress in achieving those policy goals glacial in the years ahead.
  • Macquarie now sees the RBA cash rate remaining at 1.5% until at least the end of 2020. However, unlike current financial market pricing, it does not see the RBA cutting rates.
  • Rather than further monetary policy easing, it sees a far stronger case for additional macroprudential policy easing from APRA.

The Reserve Bank of Australia (RBA) expects Australian economic growth will exceed 3% per annum both this year and next, according to forecasts released in November, helping to push unemployment lower and lift wage and inflationary pressures gradually in the period ahead.

If all goes to plan, that should allow it to begin lifting official interest rates for the first time since late 2010.

While the RBA thinks that’s a plausible outcome, Macquarie Bank does not, predicting the RBA’s optimistic growth forecasts are unlikely to be achieved, leaving the bank little choice but to keep the cash rate unchanged until at least the end of 2020.

“Growth is forecast to average around 2.7% over 2019 to 2021 which, in our view, remains modestly above the economy’s current ‘potential’ which we put at closer to 2.5% than 2.75%,” says Justin Fabo and Ric Deverell, economists at Macquarie.

Macquarie Bank

Potential growth is the level where the economy expands at a sufficient pace to keep inflation and unemployment broadly steady. Many suspect Australia’s potential growth rate is around 2.75% per annum.

The RBA currently sees GDP growing by 3.5% in 2018 before gradually decelerating to 3.25% in both 2020 and 2021.

Given the expectation that growth will undershoot the RBA’s expectations by some margin, Macquarie sees glacial progress in lowering unemployment and boosting inflationary pressures over the next few years, underpinning its view that the cash rate will remain unchanged at 1.5% over this period.

“[Our growth downgrade] has resulted in a modest lowering of the inflation outlook. Underlying inflation is expected to only reach the bottom of the RBA’s 2-3% target over the next couple of years,” Fabo and Deverell say.

“The unemployment rate is still expected to gradually decline over the next few years towards 4.5% from around 5% currently, but little if any improvement is expected this year.

“This should see a further slow pick-up in wages growth but it’s unlikely to result in the 3.25%-3.5% wage increases that are likely necessary for 2.5% inflation to be sustainable.”

While Macquarie, like the RBA, believe the next move in the cash rate is likely to be higher, Fabo and Deverell admit there’s a risk the RBA tightening cycle will never actually begin given where the global economy sits in the cycle.

“In June last year we said that we expected the RBA to start lifting the cash rate gradually from early 2020. We also flagged that there was a small but growing risk that the Bank never gets going based on our view at the time that the global economy could get a deal more interesting by 2020. That risk remains,” they say.

While that suggests the risk of a rate cut from the RBA has increased, mirroring current market pricing which puts the odds of 25 basis point rate cut at 50% by the end of this year, along with the view of an increasing number of economists, Fabo and Deverell aren’t convinced by the shift towards further policy easing in the year ahead.

Macquarie Bank

“While our updated view naturally implies a greater risk that the next move in the cash rate is down, we think that the shift in market pricing to around a 60% chance of a rate cut by early 2020 is a bit of an overreaction to a softening in economic data,” they say.

For the RBA to drop its mild tightening bias, let alone to revert to an easing bias, Macquarie says there will need to be “clear signs that the slowing in global growth is sinister and/or compelling evidence that Australia’s unemployment rate is trending higher”.

Rather than rate cuts, Fabo and Deverell say there’s a far greater chance that tighter lending restrictions will be relaxed instead, potentially removing the threat of a housing-led slowdown in the Australian economy.

“There is a non-trivial chance in our view of further macroprudential easing by APRA. Absent an easing monetary policy, this would appear more likely in an environment where the domestic economy appears reasonably OK overall but concerns about the availability of credit are heightened,” they say.

“To date, APRA’s removal of both the 10% investor credit growth speed limit and the 30% cap on the share of new housing loans that can be interest-only are largely cosmetic because lenders were nowhere near these caps anyway.”

Fabo and Deverell say Australia’s Council of Financial Regulators, encompassing staff from APRA, the RBA, ASIC and Treasury, are likely to have become more concerned about the risk of a slowdown in credit growth turning into something more damaging, increasing the odds of less-onerous criteria being applied to potential borrowers.

“A meaningful lever for APRA to pull is to reduce the minimum interest rate threshold at which lenders must assess a borrower’s debt-servicing capability,” they say, referring to the minimum 7% mortgage rate that new borrowers are assessed against.

“While the average interest rate on new variable rate owner-occupier loans is close to 4%, and numerous products have rates below this, lenders must assess new borrowers at rates more than 300 basis points higher.”

With scrutiny over household expenses now far more stringent, and with the likelihood of a steep increase in mortgage rates in the coming years remote in their opinion, Fabo and Deverell say APRA could “sensibly justify that the 7%-plus floor is now too high”.

“The hurdle for lowering the floor is still likely to be high so we wouldn’t expect a change anytime soon,” they say.

“But if the Bank and APRA reached the conclusion that lenders’ overall loan serviceability assessments had tightened so much that they are unduly restricting the flow of credit, a rational first step would be to lower the interest rate floor.

“This risk needs to be accounted for when judging the probability of cash rate cuts by the RBA.”

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